TRANSCAT INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Operational Overview. We are a leading provider of accredited calibration, repair, inspection and laboratory instrument services and a value-added distributor of professional grade handheld test, measurement and control instrumentation. We operate our business through two reportable business segments, Service and Distribution, which offer a comprehensive range of services and products to the same customer base. Our strength in our Service segment is based upon our wide range of disciplines, our investment in quality systems and our ability to provide accredited calibrations to customers in highly-regulated targeted market segments. Our services range from the calibration and repair of a single unit to managing a customer’s entire calibration program. We believe our Service segment offers an opportunity for long-term growth and the potential for continuing revenue from established customers with regular calibration cycles and recurring laboratory instrument service requirements. Our Service segment has shown consistent revenue growth over the past several years, ending fiscal year 2021 with its 48th consecutive quarter of year-over-year growth. This segment has benefited from both organic growth as well as acquisitions over those 48 quarters. The business acquisitions that we made have been heavily focused on expanding our service capabilities, increasing our geographic reach and leveraging our Calibration Service Centers and other infrastructure to create operational synergies. Our total Service revenue growth was 8.9% for fiscal year 2021 compared to fiscal year 2020, despite the COVID-19 pandemic. The Service segment gross margin increased by 500 basis points. Service gross profit and gross margin were positively impacted by ongoing productivity improvements, operating leverage from organic growth, strategic pricing and accretive margins from the pipettes.com and Bio Tek acquisitions. In our Distribution segment, we sell and offer for rent, professional grade handheld test and measurement instruments. Because we specialize in professional grade handheld test and measurement instruments, as opposed to 21 Table of Contents a wide array of industrial products, our sales and customer service personnel can provide value-added technical assistance to our customers to aid them in determining what product best meets their particular application requirements. We have expertise in the procurement and sale of used equipment, furthering our ability to add value for our customers. We also have a higher-end electronic test and measurement equipment rental business that augments our organically grown test and measurement equipment rental business. Through our website and sales teams, customers can place orders for test and measurement instruments and can elect to have their purchased instruments calibrated and certified by our Calibration Service Centers before shipment as well as on regular post-purchase intervals. Pre-shipment calibration and certification allows our customers to place newly purchased instruments into service immediately upon receipt. Sales in our Distribution segment are generally not consumable items but are instruments purchased as replacements, upgrades or for expansion of manufacturing or research and development facilities. As such, this segment can be heavily impacted by changes in the economic environment. As customers increase or decrease capital and discretionary spending, our Distribution sales will typically be directly impacted. In fiscal year 2021, Distribution sales decreased by 10.0%. These sales results were impacted by the COVID-19 pandemic, with reduced demand from oil and gas related businesses and most other industrial manufacturing sectors. In fiscal year 2020, Distribution sales increased by 4.2%. These results were driven by increased demand and revenue in all channels, especially in the alternative energy sector, used equipment and rental revenue. Overall, the Distribution segment gross margin in fiscal year 2021 decreased by 230 basis points. The decrease in segment gross margin was primarily due to reduced cooperative advertising and rebate programs as certain vendors reduced these programs to lower their costs in response to the COVID-19 pandemic. Initiatives implemented within this segment include adding new in-demand vendors and product lines, expanding the number of SKUs that we offer with and without pre-shipment calibration and offering equipment rental and used equipment options. Management believes this diversification strategy will mitigate the impact that any particular industry or sector will have on the overall performance of this segment as well as help to further differentiate us from our competitors going forward. Financial Overview. In evaluating our results for fiscal year 2021, investors should consider that we operate on a 52/53-week fiscal year, ending the last Saturday in March. In a 52-week fiscal year, each of the four quarters is a 13-week period. In a 53-week fiscal year, the last quarter is a 14-week period. Fiscal years 2021 and 2020 both consisted of 52 weeks. Management's discussion and analysis of financial condition and results of operations for the fiscal year ended March 27, 2021 omits a comparative discussion regarding the fiscal year ended March 30, 2019. Such information is located in Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended March 28, 2020 . Total revenue for fiscal year 2021 was $173.3 million. This represented an increase of $0.2 million or 0.1% versus total revenue of $173.1 million for fiscal year 2020. Total revenue was relatively flat year-over-year due to the combination of increases in Service revenue offset by decreases in Distribution sales. Service revenue was $101.3 million in fiscal year 2021, an increase of $8.3 million or 8.9%. Service revenue now accounts for 58.4% of our total revenue. Of our Service revenue in fiscal year 2021, 83.6% was generated by our Calibration Service Centers while 14.9% was generated through subcontracted third-party vendors, compared with 83.5% and 14.9%, respectively, in fiscal year 2020. The remainder of our Service revenue in each period was derived from freight charges. Distribution sales decreased 10.0% to $72.1 million in fiscal year 2021. Distribution sales accounted for 41.6% of our total revenue. Sales to domestic customers comprised 92.8% of total Distribution sales in fiscal year 2021, while 6.1% were to Canadian customers and 1.1% were to customers in other international markets. Total gross profit was $46.1 million in fiscal year 2021 compared to $42.5 million in fiscal year 2020, an increase of $3.6 million or 8.6%. Total gross margin was 26.6%, which is a 210 basis point increase versus fiscal year 2020. Service gross margin was 30.3% in fiscal year 2021 compared with 25.3% in fiscal year 2020. Distribution gross margin was 21.4% in fiscal year 2021 compared with 23.7% in fiscal year 2020. Operating expenses were $35.0 million, or 20.2% of total revenue, in fiscal year 2021 compared with $31.6 million, or 18.3% of total revenue, in fiscal year 2020. Operating income was $11.1 million, or 6.4% of total revenue, in fiscal year 2021 compared with $10.9 million, or 6.3% of total revenue, in fiscal year 2020. 22 Table of Contents Net income for fiscal year 2021 was $7.8 million compared with $8.1 million in fiscal year 2020, a $0.3 million decrease. Diluted earnings per share for fiscal year 2021 was $1.03 compared with $1.08 for fiscal year 2020, a $0.05 per diluted share decline. COVID-19 Impact. The COVID-19 pandemic had a negative impact on our fiscal year 2021 operations and financial results, and even with the vaccine roll-outs and mask mandates being lifted, the full financial impact of the pandemic going forward cannot be reasonably estimated at this time due to uncertainty as to its severity and duration, especially as new variants continue to appear. We have taken steps to help mitigate the current impact, as well as the continued uncertainty regarding the ultimate impact of the COVID-19 pandemic on our business, results of operations, financial position and cash flows. · Currently, our network of labs, distribution center and support facilities remain fully operational. We do not anticipate disruptions to the Distribution supply chain in the short-term and are working with partners to minimize any potential delays. · We have established a cross-functional COVID-19 task force, which meets regularly, to standardize continuity plans and daily practices across the 42 Calibration Service Centers, client-based labs and our distribution/rental operations for responding to the rapidly changing issues around this global pandemic. Actions instituted include: · Adhering to guidelines and recommendations of the Centers for Disease Control and Prevention and World Health Organization to reduce the spread of COVID-19; · Established a pandemic protocol across the organization to ensure continuous service to customers and mitigate risk; · Suspended all work-related travel except for direct onsite service to customers. When performing necessary onsite service for customers, we are following recommended protocols including self-assessments and travel disclosures and asking the same from our customers; · Required personnel whose roles allow to work remotely from home in order to adhere to the social distancing recommendations issued by global health officials; · Aligned variable costs with demand, a freeze on wage increases, and tightly controlling discretionary spending; · Reduced the CEO’s salary and Board of Director cash retainer fees by 20% and reduced other executive team members salaries by 10% during the first and second quarters of fiscal 2021; · Leveraging government work programs, tax deferrals and extensions; and · Amended our revolving credit facility to provide for, among other things, $10.0 million in additional borrowing capacity and financial covenant modifications. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Use of Estimates. The preparation of our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (“GAAP”) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are used for, but not limited to, allowance for doubtful accounts and returns, inventory reserves, estimated levels of achievement for performance-based restricted stock units, fair value of stock options, depreciable lives of fixed assets, estimated lives of major catalogs and intangible assets, and the valuation of assets acquired and liabilities assumed in business acquisitions. Future events and their effects cannot be predicted with certainty; accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our Consolidated Financial Statements will change as new events occur, as more experience is acquired, as additional information is obtained, and as our operating environment changes. Our estimates are evaluated on an ongoing basis and are drawn from historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Such changes and refinements in estimation methodologies are reflected in reported results of operations in the period in which the changes are made and, if material, their effects are disclosed in the Notes to our Consolidated Financial Statements. The following items in our Consolidated Financial Statements require significant estimation or judgment: Accounts Receivable. Accounts receivable represent amounts due from customers in the ordinary course of business. These amounts are recorded net of the allowance for doubtful accounts and returns in the Consolidated 23 Table of Contents Balance Sheets. The allowance for doubtful accounts is based upon the expected collectability of accounts receivable. We apply a specific formula to our accounts receivable aging, which may be adjusted on a specific account basis where the formula may not appropriately reserve for loss exposure. After all attempts to collect a receivable have failed, the receivable is written-off against the allowance for doubtful accounts. The returns reserve is calculated based upon the historical rate of returns applied to revenues over a specific timeframe. The returns reserve will increase or decrease as a result of changes in the level of revenues and/or the historical rate of returns. Management believes that the allowances are appropriate to cover anticipated losses under current conditions. However, unexpected changes or deterioration in economic conditions could materially change these expectations. Inventory. Inventory consists of products purchased for resale and is valued at the lower of cost or net realizable value. Costs are determined using the average cost method of inventory valuation. Inventory is reduced by a reserve for items not saleable at or above cost by applying a specific loss factor, based on historical experience and current demand, to specific categories of our inventory. Inventory is at risk of obsolescence if economic conditions change. Relevant economic conditions include changing consumer demand, customer preferences or increasing competition. We believe these risks are largely mitigated because our inventory typically turns several times per year. We evaluate the adequacy of the reserve on a quarterly basis. Business Acquisitions. We apply the acquisition method of accounting for business acquisitions. Under the acquisition method, identifiable assets acquired and liabilities assumed are measured at their acquisition-date fair value. We use a valuation hierarchy to determine the fair values used. Historically, we have relied, in part, upon the use of reports from third-party valuation specialists to assist in the estimation of fair values. Purchase price allocations are subject to revision within the measurement period, not to exceed one year from the date of acquisition. Administration costs to acquire a business may include, but are not limited to, fees for accounting, legal and valuation services and are recorded as incurred in our Consolidated Statement of Income. Goodwill and Intangible Assets. Goodwill represents the excess of the purchase price over the values assigned to the underlying net assets of an acquired business and is not amortized. As of March 27, 2021, we had $43.3 million of recorded goodwill. Intangible assets, namely customer base and covenants not to compete, represent an allocation of purchase price to identifiable intangible assets of an acquired business. These intangible assets are amortized over their estimated useful lives and are reviewed for impairment if and when indicators are present. We estimate the fair value of our reporting units using the fair market value measurement requirement. We test goodwill for impairment on an annual basis during the fourth quarter of each fiscal year or immediately if conditions indicate that such impairment could exist. We have the option to perform a qualitative assessment to determine if it is more likely than not that the fair value of a segment has declined below its carrying value. This assessment considers various financial, macroeconomic, industry and segment specific qualitative factors. Intangible assets are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Based on the results of our reviews, we have determined that no impairment was indicated as of each of the fiscal years ended March 27, 2021 and March 28, 2020. Income Taxes. We record deferred income taxes for the effects of timing differences between financial and tax reporting. These differences relate primarily to accrued expenses, bad debt reserves, inventory reserves, operating leases, goodwill and intangible assets, depreciation and amortization and stock based compensation. We base our deferred income taxes, accrued income taxes and provision for income taxes upon income, statutory tax rates, the legal structure of our Company, interpretation of tax laws and tax planning opportunities available to us in the various jurisdictions in which we operate. We file income tax returns in the U.S. federal jurisdiction, various states and Canada. We are regularly audited by federal, state and foreign tax authorities, but a number of years may elapse before an uncertain tax position, for which we have unrecognized tax benefits, is audited and finally resolved. From time to time, these audits result in assessments of additional tax. If a loss is determined to be probable as a result of an audit, an accrual is established. We apply a more-likely-than-not threshold to the recognition and derecognition of uncertain tax positions. Accordingly, we recognize the amount of tax benefit that has a greater than 50% likelihood of being ultimately realized upon settlement. Future changes in judgments and estimates related to the expected ultimate resolution of uncertain tax positions will affect income in the quarter of such change. While it is often difficult to predict the final 24 Table of Contents outcome or the timing of resolution of any particular uncertain tax position, we believe that our unrecognized tax benefits reflect the most likely outcome. Stock-Based Compensation. We measure the cost of services received in exchange for all equity awards granted, including stock options and restricted stock units, based on the fair market value of the award as of the grant date. We record compensation cost related to unvested equity awards by recognizing, on a straight-line basis, the unamortized grant date fair value over the remaining service period of each award. In accordance with Accounting Standards Updates (“ASU”) 2016-09, excess tax benefits for share-based award activity are reflected in the Consolidated Statement of Income as a component of the provision for income taxes. Excess tax benefits are realized benefits from tax deductions for exercised awards in excess of the deferred tax asset attributable to stock-based compensation costs for such awards. We did not capitalize any stock-based compensation costs as part of an asset. We estimate forfeiture rates based on our historical experience. We grant timed-based and performance-based restricted stock units as a component of executive and key employee compensation. These restricted stock units are either time vested or vest following the third fiscal year from the date of grant and some of these grants are subject to cumulative diluted earnings per share growth targets over the eligible period. Compensation cost ultimately recognized for these restricted stock units will equal the grant-date fair market value of the unit that coincides with the actual outcome of the performance conditions. On an interim basis, we record compensation cost based on the expected level of achievement of the performance conditions. Stock options vest either immediately or over a period of up to five years using a straight-line basis, and expire either five years or ten years from the date of grant. The expense relating to options is recognized on a straight-line basis over the requisite service period for the entire award. See Note 6 to our Consolidated Financial Statements for further disclosure regarding our stock-based compensation. Post-retirement Health Care Plans. The Company has a defined benefit post-retirement health care plan which provides long-term care insurance benefits, medical and dental insurance benefits, and medical premium reimbursement benefits to eligible retired corporate officers and their eligible spouses. For accounting purposes, the defined benefit post-retirement health care plan requires assumptions to estimate the projected and accumulated benefit obligations, including the following variables: discount rate; certain employee-related factors, such as retirement age and mortality; and health care cost trend rates. These and other assumptions affect the annual expense and obligations recognized for the underlying plans. Our assumptions reflect our historical experiences and management's best judgment regarding future expectations. Increasing the assumed health care cost trend rate by one percentage point would increase the accumulated post-retirement benefit obligation and the annual net periodic post-retirement benefit cost by $0.2 million. A one percentage point decrease in the healthcare cost trend would decrease the accumulated post-retirement benefit obligation and the annual net periodic post-retirement benefit cost by $0.2 million. Recently Issued Accounting Pronouncements . In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”) to determine the potential impact they may have on our consolidated financial statements. For a discussion of the newly issued accounting pronouncements see “Recently Issued Accounting Pronouncements” under Note 1 to the Consolidated Financial Statements included in Item 8 of Part II of this report. 25 Table of Contents RESULTS OF OPERATIONS The following table sets forth, for fiscal years 2021 and 2020, the components of our Consolidated Statements of Income. FY 2021 FY 2020 As a Percentage of Total Revenue: Service Revenue 58.4% 53.7% Distribution Sales 41.6% 46.3% Total Revenue 100.0% 100.0% Gross Profit Percentage: Service Gross Profit 30.3% 25.3% Distribution Gross Profit 21.4% 23.7% Total Gross Profit 26.6% 24.5% Selling, Marketing and Warehouse Expenses 10.2% 10.4% General and Administrative Expenses 10.0% 7.9% Total Operating Expenses 20.2% 18.3% Operating Income 6.4% 6.3% Interest and Other Expenses, net 0.6% 0.7% Income Before Provision for Income Taxes 5.8% 5.6% Provision for Income Taxes 1.3% 0.9% Net Income 4.5% 4.7% FISCAL YEAR ENDED MARCH 27, 2021 COMPARED TO FISCAL YEAR ENDED MARCH 28, 2020 (dollars in thousands): Revenue: For the Fiscal Years Ended March 27, March 28, Change 2021 2020 $ % Revenue: Service $ 101,274 $ 93,003 $ 8,271 8.9% Distribution 72,061 80,096 (8,035) (10.0%) Total $ 173,335 $ 173,099 $ 236 0.1% Total revenue was $173.3 million in fiscal year 2021 compared to $173.1 million in fiscal year 2020, an increase of $0.2 million or 0.1%. Service revenue, which accounted for 58.4% and 53.7% of our total revenue in fiscal years 2021 and 2020, respectively, increased $8.3 million, or 8.9% from fiscal year 2020 to fiscal year 2021. This year-over-year growth includes a combination of organic and acquisition-related revenue growth. This year-over-year increase reflected new life science business and, combined with $5.2 million of incremental revenue from pipettes.com and BioTek, more than offset reduced demand from other markets caused primarily by the COVID-19 pandemic. Excluding acquired revenue of $5.2 million, the Service segment organic revenue increased by 3.3%. Our fiscal years 2021 and 2020 Service revenue growth in relation to prior fiscal year quarter comparisons, was as follows: FY 2021 FY 2020 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Service Revenue Growth 15.8% 12.2% 4.5% 2.5% 2.9% 7.8% 18.1% 15.9% Within any year, while we add new customers, we also have customers from the prior year whose service orders may not repeat for any number of factors. Among those factors are variations in the timing of periodic calibrations and other services, customer capital expenditures and customer outsourcing decisions. Because the timing of Service segment orders can vary on a quarter-to-quarter basis, we believe a trailing twelve-month trend provides a better indication of the progress of this segment. The growth in fiscal year 2021 and fiscal year 2020 reflected both organic growth and acquisitions. The growth in Service segment revenue during the third and fourth quarters of fiscal year 2021 includes revenue from Bio Tek and pipettes.com. The growth in Service segment revenue during 26 Table of Contents the first and second quarters of fiscal year 2021 and the fourth quarter of fiscal year 2020 includes revenue from the pipettes.com acquisition. The following table presents the trailing twelve-month Service segment revenue for each quarter in fiscal years 2021 and 2020 as well as the trailing twelve-month revenue growth as a comparison to that of the prior fiscal year period: FY 2021 FY 2020 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Trailing Twelve-Month: Service Revenue $101,274 $97,225 $94,624 $93,572 $93,003 $92,309 $90,714 $87,114 Service Revenue Growth 8.9% 5.4% 4.3% 7.4% 10.7% 13.0% 13.5% 11.3% Our strategy has been to focus our investments in the core electrical, temperature, pressure, physical/dimensional and radio frequency/microwave calibration disciplines. We expect to subcontract approximately 13% to 15% of our Service revenue to third-party vendors for calibration beyond our chosen scope of capabilities. We continually evaluate our outsourcing needs and make capital investments, as deemed necessary, to add more in-house capabilities and reduce the need for third-party vendors. Capability expansion through business acquisitions is another way that we seek to reduce the need for outsourcing. The following table presents the source of our Service revenue and the percentage of Service revenue derived from each source for each quarter during fiscal years 2021 and 2020: FY 2021 FY 2020 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 In-House 83.6% 83.1% 83.7% 82.9% 84.9% 82.9% 82.9% 83.3% Outsourced 14.9% 15.3% 14.7% 15.6% 13.5% 15.6% 15.6% 15.1% Freight Billed to Customers 1.5% 1.6% 1.6% 1.5% 1.6% 1.5% 1.5% 1.6% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Our Distribution sales accounted for 41.6% and 46.3% of our total revenue in fiscal years 2021 and 2020, respectively. Distribution sales decreased $8.0 million, or 10.0% in fiscal year 2021 compared to fiscal year 2020. Fiscal year 2021 results were impacted by the COVID-19 pandemic, with reduced demand from oil and gas related businesses and most other industrial manufacturing sectors. However, rental revenue increased by 1.6% to $5.1 million in fiscal year 2021 compared to fiscal year 2020. The change in fiscal year 2021 versus fiscal year 2020 and the increase in fiscal year 2020 versus fiscal year 2019 reflected both organic and acquisition revenue. Our fiscal years 2021 and 2020 Distribution sales (decline) growth in relation to prior fiscal year quarter comparisons were as follows: FY 2021 FY 2020 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Distribution Sales (Decline) Growth (4.6%) (8.6%) (6.6%) (20.3%) 2.9% 3.5% (3.8%) 15.4% Distribution sales orders include orders for instruments that we routinely stock in our inventory, customized products, and other products ordered less frequently, which we do not stock. Pending product shipments are primarily backorders, but also include products that are requested to be calibrated in our service centers prior to shipment, orders required by the customer to be shipped complete or at a future date, and other orders awaiting final credit or management review prior to shipment. Our total pending product shipments increased $2.0 million, or 45.2%, at the end of fiscal year 2021 compared to the end of fiscal year 2020. Backorders at the end of fiscal year 2021 were $4.9 million, compared to $2.9 million at the end of fiscal year 2020. The year-over-year increase in pending product shipments and backorders was a result of the COVID-19 pandemic and its disruption to the supply of products. The following table presents the percentage of total pending product shipments that were backorders at the end of each quarter in fiscal years 2021 and 2020 and our historical trend of total pending product shipments: 27 Table of Contents FY 2021 FY 2020 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Total Pending Product Shipments $6,287 $5,533 $4,251 $3,890 $4,330 $3,743 $4,025 $4,115 % of Pending Product Shipments that were Backorders 77.6% 79.3% 76.6% 75.8% 66.5% 77.6% 71.7% 77.2% Gross Profit: For the Fiscal Years Ended March 27, March 28, Change 2021 2020 $ % Gross Profit: Service $ 30,695 $ 23,486 $ 7,209 30.7% Distribution 15,423 18,992 (3,569) (18.8%) Total $ 46,118 $ 42,478 $ 3,640 8.6% Total gross profit in fiscal year 2021 was $46.1 million compared to $42.5 million in fiscal year 2020, an increase of $3.6 million or 8.6%. As a percentage of total revenue, total gross margin was 26.6% in fiscal year 2021 compared to 24.5% in fiscal year 2020. Service gross profit increased $7.2 million, or 30.7%, from fiscal year 2020 to fiscal year 2021. Our annual and quarterly Service segment gross margins are a function of several factors. Our organic Service revenue growth provides some incremental gross margin growth by leveraging certain fixed costs of this segment. The mix of services provided to customers may also affect gross margins in any given period. Annual Service gross margin increased by 500 basis points from fiscal year 2020 to fiscal year 2021. This increase in service gross margin in fiscal year 2021 was primarily due to ongoing productivity improvements, operating leverage from organic growth, strategic pricing and accretive margins from the pipettes.com and Bio Tek acquisitions. The following table presents the quarterly historical trend of our Service gross margin as a percent of Service revenue: FY 2021 FY 2020 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Service Gross Margin 33.9% 27.9% 32.2% 26.4% 28.9% 22.0% 25.6% 24.0% Our Distribution gross margin includes net sales less the direct cost of inventory sold and the direct costs of equipment rental revenues, primarily depreciation expense for the fixed assets in our rental equipment pool, as well as the impact of rebates and cooperative advertising income we receive from vendors, freight billed to customers, freight expenses and direct shipping costs. During fiscal year 2021, we saw a number of our vendors significantly reduce the rebates offered to us as they implemented cost cutting measures in response to the COVID-19 pandemic. We recorded vendor rebates of $0.7 million and $1.6 million in fiscal years 2021 and 2020, respectively, as a reduction of cost of Distribution sales. In general, our Distribution gross margin can vary based upon the mix of products sold, price discounting, the timing of periodic vendor rebates offered and cooperative advertising programs from suppliers. The following table reflects the quarterly historical trend of our Distribution gross margin as a percent of Distribution sales: FY 2021 FY 2020 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Distribution Gross Margin 21.0% 22.5% 21.1% 21.0% 23.2% 24.0% 24.3% 23.4% Annual Distribution segment gross margin decreased 230 basis points in fiscal year 2021 compared to fiscal year 2020. The decrease in segment gross margin was primarily due to reduced cooperative advertising and rebate programs as certain vendors reduced these programs to lower their costs in response to the COVID-19 pandemic. 28 Table of Contents Operating Expenses: For the Fiscal Years Ended March 27, March 28, Change 2021 2020 $ % Operating Expenses: Selling, Marketing and Warehouse $ 17,743 $ 17,985 $ (242) (1.3%) General and Administrative 17,302 13,643 3,659 26.8% Total $ 35,045 $ 31,628 $ 3,417 10.8% Total operating expenses were $35.0 million in fiscal year 2021 compared to $31.6 million in fiscal year 2020. This represented an increase of $3.4 million, or 10.8%, compared to fiscal year 2020. As a percentage of total revenue, operating expenses increased 190 basis points from 18.3% in fiscal year 2020 to 20.2% in fiscal year 2021. Selling, marketing and warehouse expenses decreases were due to reduced commissions and incentives as a result of the COVID-19 pandemic. The year-over-year increase in General and Administrative expenses includes incremental expenses related to the acquisition of pipettes.com and BioTek and increased expenses related to our continued investment in technology and operational infrastructure. Provision for Income Taxes: For the Fiscal Years Ended March 27, March 28, Change 2021 2020 $ % Provision for Income Taxes $ 2,191 $ 1,663 $ 528 31.7% Our effective tax rates for fiscal years 2021 and 2020 were 21.9% and 17.1%, respectively. The increase in tax rate is due to the lower discrete tax benefits from share-based compensation activity. Our provision for income taxes is affected by discrete items that may occur in any given period but are not consistent from year to year. The discrete benefits related to share-based compensation activity in fiscal years 2021 and 2020 were $0.3 million and $0.9 million, respectively. We continue to evaluate our tax provision on a quarterly basis and adjust, as deemed necessary, our effective tax rate given changes in facts and circumstances expected in the future. We expect to receive certain federal, state and Canadian tax credits in future years. We also expect to receive discrete tax benefits related to share-based compensation awards in fiscal year 2022. As such, we expect our effective tax rate in fiscal year 2022 to be between 20.0% and 22.0%. Net Income: For the Fiscal Years Ended March 27, March 28, Change 2021 2020 $ % Net Income $ 7,791 $ 8,067 $ (276) (3.4%) Net income for fiscal year 2021 decreased by $0.3 million or 3.4% compared to fiscal year 2020. As a percentage of revenue, net income was 4.5% in fiscal year 2021, down from 4.7% in fiscal year 2020. This year-over-year change reflects higher operating income discussed above offset by a higher effective tax rate. Adjusted EBITDA: In addition to reporting net income, a GAAP measure, we present Adjusted EBITDA (earnings before interest, income taxes, depreciation and amortization, non-cash stock compensation expense, non-cash loss on sale of building, and restructuring expense), which is a non-GAAP measure. Our management believes Adjusted EBITDA is an important measure of our operating performance because it allows management, investors and others to evaluate and compare the performance of our core operations from period to period by removing the impact of the capital structure (interest), tangible and intangible asset base (depreciation and amortization), taxes, 29 Table of Contents stock-based compensation expense and other items, which is not always commensurate with the reporting period in which it is included. As such, our management uses Adjusted EBITDA as a measure of performance when evaluating our business segments and as a basis for planning and forecasting. Adjusted EBITDA is also commonly used by rating agencies, lenders and other parties to evaluate our credit worthiness. Adjusted EBITDA is not a measure of financial performance under GAAP and is not calculated through the application of GAAP. As such, it should not be considered as a substitute or alternative for the GAAP measure of net income and, therefore, should not be used in isolation of, rather in conjunction with, the GAAP measure. Adjusted EBITDA, as presented, may produce results that vary from the GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies. For the Fiscal Years Ended March 27, March 28, 2021 2020 Net Income $ 7,791 $ 8,067 + Interest Expense 850 934 + Other Expense 241 186 + Tax Provision 2,191 1,663 Operating Income 11,073 10,850 + Depreciation & Amortization 7,580 6,658 + Restructuring Expense 650 - + Other (Expense) Income (241) 15 + Noncash Stock Compensation 1,513 884 Adjusted EBITDA $ 20,575 $ 18,407 During fiscal year 2021, Adjusted EBITDA was $20.6 million, an increase of $2.2 million or 11.8% compared to fiscal year 2020. As a percentage of revenue, Adjusted EBITDA was 11.9% during fiscal year 2021 versus 10.6% during fiscal year 2020, a 110 basis point increase. The increase in Adjusted EBITDA during fiscal year 2021 is primarily driven by the increase in operating income, depreciation and amortization expense and noncash stock compensation expense. LIQUIDITY AND CAPITAL RESOURCES We expect that foreseeable liquidity and capital resource requirements will be met through anticipated cash flows from operations and borrowings from our Revolving Credit Facility (as defined below). On May 18, 2020, we entered into an amendment (“Amendment Two”) to our Amended and Restated Credit Agreement with Manufacturers and Traders Trust Company, as previously amended pursuant to an amendment dated as of December 10, 2018 (together, the “Credit Agreement”). Amendment Two extended the term of our $30.0 million revolving credit facility (the “Revolving Credit Facility”) to October 20, 2022 and increased the revolving credit commitment to $40.0 million. Amendment Two modified the definition of applicable rate used to determine interest charges on outstanding and unused borrowings under the Revolving Credit Facility and it amended the definition of permitted acquisitions to amend borrowings available under the Revolving Credit Facility for acquisitions. In addition, Amendment Two amended the definition of restricted payments to exclude amounts up to $2.5 million during each fiscal year used to pay certain employee tax obligations related to stock-based payment and stock option activity, and modified certain restrictions to our ability to repurchase our shares and pay dividends. Amendment Two modified the leverage ratio and fixed charge coverage ratio covenants with which we are required to comply. Amendment Two also established a LIBOR floor of 1% and included a mechanism for adoption of a different benchmark rate when LIBOR is discontinued. During the third quarter of fiscal year 2021, Manufacturers and Traders Trust Company eliminated the prior requirement included in Amendment Two that limited capital expenditures to $5.5 million for the fiscal year ending March 27, 2021. During the fourth quarter of fiscal year 2021, Manufacturers and Traders Trust Company eliminated the prior requirement included in Amendment Two that limited restricted 30 Table of Contents payments up to $2.5 million to pay certain tax obligations associated with share-based payment and stock option activity for the fiscal year ending March 27, 2021. On December 10, 2018, we entered into an Amended and Restated Credit Agreement Amendment 1 (the “2018 Agreement”) that provides for the 2018 Term Loan in the amount of $15.0 million, which replaced the previous 2017 Term Loan. As of March 27, 2021, $10.6 million was outstanding on the 2018 Term Loan, of which $2.0 million was included in current liabilities on the Consolidated Balance Sheets with the remainder included in long-term debt. The 2018 Term Loan requires total repayments (principal plus interest) of $0.2 million per month through December 2025. Principal payments relating to the 2018 Term Loan will be $2.1 million in fiscal year 2022, $2.2 million in fiscal year 2023, $2.2 million in fiscal year 2024, $2.3 million in fiscal year 2025 and $1.8 million in fiscal year 2026. As of March 27, 2021, $40.0 million was available under the Revolving Credit Facility, of which $8.9 million was outstanding and included in long-term debt on the Consolidated Balance Sheets. Under the Credit Agreement, borrowings that may be used for business acquisitions are limited to $20.0 million per fiscal year, and during a portion of fiscal year 2021 were limited to $5.5 million. During fiscal year 2021, $3.6 million of borrowings was used for business acquisitions. During fiscal year 2020, $13.8 million was used for business acquisitions, including holdback payments. The allowable leverage ratio under the Credit Agreement for the first, second, third and fourth fiscal quarter of fiscal year 2021, and the first quarter of fiscal year 2022 is a maximum multiple of 3.0, 5.0, 5.5, 7.0 and 4.0, respectively, of total debt outstanding compared to EBITDA and non-cash stock-based compensation expense for the preceding four consecutive fiscal quarters. After the first quarter of fiscal 2022, the allowable leverage ratio is a maximum multiple of 3.0. The Credit Agreement provides that the trailing twelve-month pro forma EBITDA of an acquired business is included in the allowable leverage calculation. The Credit Agreement has certain covenants with which we must comply, including a fixed charge ratio covenant and a leverage ratio covenant. We were in compliance with all loan covenants and requirements during fiscal years 2021 and 2020. Our leverage ratio, as defined in the Credit Agreement, was 0.94 at March 27, 2021 compared with 1.53 at March 28, 2020. Interest on the Revolving Credit Facility continues to accrue, at our election, at either the variable one-month LIBOR (subject to a 1% floor) or a fixed rate for a designated period at the LIBOR corresponding to such period, in each case, plus a margin. Interest on outstanding borrowings of the 2018 Term Loan accrues at a fixed rate of 4.15% over the term of the loan with principal and interest payments made monthly. Unused fees accrue based on the average daily amount of unused credit available under the Credit Agreement. Interest rate margins and unused fees are determined on a quarterly basis based upon our calculated leverage ratio, as defined in the Credit Agreement. On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was enacted. The CARES Act included a provision that allows the Company to defer the employer portion of social security payroll tax payments that would have been paid between the enactment date and December 31, 2020, with 50% payable by December 31, 2021 and 50% payable by December 31, 2022. During fiscal year 2021, the Company deferred $2.0 million of employer social security payroll taxes, of which $1.0 million is recorded in accrued compensation and other liabilities and $1.0 million is recorded in other liabilities on the Consolidated Balance Sheets. Cash Flows: The following table is a summary of our Consolidated Statements of Cash Flows (dollars in thousands): For the Fiscal Years Ended March 27, March 28, 2021 2020 Cash Provided by (Used in): Operating Activities $ 23,639 $ 11,561 Investing Activities $ (10,151) $ (20,242) Financing Activities $ (12,655) $ 8,247 31 Table of Contents Operating Activities: Net cash provided by operating activities was $23.6 million during fiscal year 2021 compared to $11.6 million during fiscal year 2020 primarily due to changes in net working capital (defined as current assets less current liabilities). The significant changes in net working capital were: · Cash: Cash increased by $0.1 million during fiscal year 2021. The increase was primarily due to the timing of payments towards our long-term debt. · Receivables: Accounts receivable increased by a net amount of $3.0 million during fiscal year 2021, inclusive of $0.4 million of accounts receivable acquired as part of the BioTek acquisition completed during the period. Accounts receivable increased by a net amount of $3.5 million during fiscal year 2020, including $0.8 million of accounts receivable acquired as part of the pipettes.com acquisition completed within the period. The year-over-year change reflects the timing of collections. The following table illustrates our days sales outstanding as of March 27, 2021 and March 28, 2020: For the Fiscal Years Ended March 27, March 28, 2021 2020 Net Sales, for the last two fiscal months $ 36,536 $ 34,241 Accounts Receivable, net $ 33,950 $ 30,952 Days Sales Outstanding 56 54 · Inventory: Our inventory strategy includes making appropriate large quantity, high dollar purchases with key manufacturers for various reasons, including maximizing on-hand availability of key products, expanding the number of SKUs stocked in anticipation of customer demand, reducing backorders for products with long lead times and optimizing vendor purchase and sales volume discounts. As a result, inventory levels may vary from quarter-to-quarter based on the timing of these large orders in relation to our quarter end. Our inventory balance decreased $2.5 million during fiscal year 2021. Our inventory balance decreased $0.1 million during fiscal year 2020, including $0.1 million of inventory acquired from the pipettes.com acquisition completed within the period. The year-over-year change is a result of lower distribution sales as a result of lower demand due to COVID-19. · Accounts Payable: Changes in accounts payable may or may not correlate with changes in inventory balances at any given quarter end due to the timing of vendor payments for inventory, as well as the timing of payments for outsourced Service vendors and capital expenditures. Accounts payable increased by $0.3 million during fiscal year 2021. Accounts payable decreased by $2.6 million during fiscal year 2020. The variance is largely due to the timing of inventory purchases and other payments in the respective periods. · Accrued Compensation and Other Current Liabilities: Accrued compensation and other current liabilities include, among other things, amounts paid to employees for non-equity performance-based compensation. At the end of any particular period, the amounts accrued for such compensation may vary due to many factors including, but not limited to, changes in expected performance levels, the performance measurement period, and the timing of payments to employees. During fiscal year 2021, accrued compensation and other liabilities increased by $3.5 million, due primarily to increased accrued incentives and payroll related expense and $1.0 million of deferred employer portion of social security payroll tax payments as part of the CARES Act. During fiscal year 2020, accrued compensation and other liabilities increased by $1.5 million, due primarily to the adoption of the new lease accounting standard. · Income Taxes Payable: In any given period, net working capital may be affected by the timing and amount of income tax payments. During fiscal year 2021, income taxes payable increased by $0.3 million while during fiscal year 2020, income taxes payable decreased by $0.1 million. The year-over-year difference is due to timing of income tax payments. Investing Activities: During fiscal year 2021, we invested $6.6 million in capital expenditures that was used primarily for customer-driven expansion of Service segment capabilities and our rental business. During fiscal year 2020, we invested $6.6 million in capital expenditures that was used primarily for 32 Table of Contents technology infrastructure to drive operational excellence, fund organic growth opportunities within both operating segments and to purchase new equipment to expand the number and type of assets available to rent. The purchase of assets from GRS during fiscal year 2020 is included in our capital expenditures above. During fiscal year 2021, we used $3.6 million for business acquisitions. During fiscal year 2020, we used $13.0 million for business acquisitions. During fiscal year 2021, no contingent consideration or other holdback amounts were paid related to a business acquisition. During fiscal year 2020, we used $0.9 million for holdback payments related to a business acquisition. Financing Activities : During fiscal year 2021, $1.2 million in cash was generated from the issuance of our common stock. In addition, we repaid $8.8 million of our Revolving Credit Facility, we used $2.0 million for scheduled repayments of our term loan, and used $3.0 million for the “net” award of certain share awards to cover tax-withholding obligations for share award activity in the period which are shown as a repurchase of shares of our common stock. During fiscal year 2020, we received $11.2 million from our Revolving Credit Facility and $1.7 million in cash was generated from the issuance of our common stock. We used $1.9 million for scheduled repayments of our term loan and used $2.8 million for the “net” award of certain share awards to cover tax-withholding obligations for share award activity in the period which are shown as a repurchase of shares of our common stock. Recent Events Effective April 29, 2021, Transcat acquired substantially all of the assets of Upstate Metrology Inc. (“Upstate Metrology”), a New York based provider of calibration services. This transaction aligned with a key component of our acquisition strategy of targeting businesses that expand the depth and breadth of the Company’s service capabilities. The total purchase price paid for the assets of Upstate Metrology was approximately $0.9 million. OUTLOOK We are proud of the performance and dedication of the entire Transcat team in the fourth quarter and throughout fiscal 2021 as we navigated the most challenging operating environment in the history of our company. We enter fiscal 2022 with a strong balance sheet, what we believe are sustainable Service segment gross margins and an active M&A pipeline. We are optimistic that our disciplined focus on highly-regulated end markets and our new customer pipeline positions us well for continued strong organic growth. For the first quarter of fiscal 2022, we expect Service organic growth to be similar to what we achieved in the fourth quarter of fiscal 2021. We expect improvement in Service gross margins, but not to the same degree we experienced in fiscal 2021, largely due to more difficult technician productivity comparisons and the recent anniversary of our acquisition of pipettes.com which occurred in February 2020. Distribution is expected to achieve double-digit growth in the first quarter on modestly improving trends and a prior-year comparison that includes low levels of demand due to the onset of the COVID-19 pandemic. Total operating expenses are expected to be similar to the trailing fourth quarter of fiscal year 2021. We expect to receive certain federal, state and Canadian tax credits in future years. We also expect to receive discrete tax benefits related to share-based compensation awards in fiscal year 2022. As such, we expect our effective tax rate in fiscal year 2022 to be between 20.0% and 22.0%. The Company anticipates total capital expenditures to be approximately $7.5 million to $8.5 million in fiscal year 2022, with the majority of the capital expenditures planned for growth-oriented opportunities within both of its operating segments, and for rental pool assets.